Question

Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt-equity ratio of .7. It’s considering building a new $65 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $7.7 million in perpetuity. The company raises all equity from outside financing. There are three financing options:

1.	A new issue of common stock: The flotation costs of the new common stock would be 7.3 percent of the amount raised. The required return on the company’s new equity is 14 percent.
2.	A new issue of 20-year bonds: The flotation costs of the new bonds would be 2.8 percent of the proceeds. If the company issues these new bonds at an annual coupon rate of 4 percent, they will sell at par.
3.	Increased use of accounts payable financing: Because this financing is part of the company’s ongoing daily business, it has no flotation costs, and the company assigns it a cost that is the same as the overall firm WACC. Management has a target ratio of accounts payable to long-term debt of .15. (Assume there is no difference between the pretax and aftertax accounts payable cost.)

What is the NPV of the new plant? Assume that PC has a 23 percent tax rate. (Do not round intermediate calculations and enter your answer in dollars, not millions, rounded to the nearest whole dollar amount, e.g., 1,234,567.)

Answer 1

4.00% C D E Weights Weighted cost Pre-tax cost of debt 0.8696 2.43% 0.1304 0.00% After-tax cost of debt 2 3 Flotation cost (r) 2.80% 0.00% Long-term debt Accounts payable 3.08% 4 Total debt 1.0000 Required return on new equity 14.0% 7 Flotation cost of debt M= 2.43% Flotation cost (r) 2.43% 7.30% Weights Weighted cost 0.4118 1.00% 0.5882 4.29% 9 10 Debt 11 Equity 12 13 14 15 16 17 Initial cost Total debt 1.0000 Weighted flotation cost 5.30% 68,635,394 18 9.87% 19 WACC 20 21 NPV $9,393,747

G Flotation cost (r) Pre-tax cost of debt 0.04 1 2 Long-term debt 0.028 3 Accounts payable o Weights =1/1.15 =0.15/1.15 D Weighted cost =C2*B2 =C3*B3 After-tax cost of debt =G1*(1-23%) Total debt =SUM(C2:04) Required return on new equity 0.14 Flotation cost of debt u = =SUM(D2:D3) 9 Flotation cost (r) =D7 0.073 | Weights =0.7/1.7 =1/1.7 Weighted cost =C10*B10 =C11*B11 Total debt =SUM(C10:C12) 10 Debt 11 Equity 12 13 14 15 16 17 Initial cost Weighted flotation cost u = =SUM(D10:011) =65000000/(1-D15) 18 =(C11*G5+C10*22*G3)/(1-C10*C3) 19 WACC 20 21 NPV =7700000/B19-B17

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